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What is a sole trader? There are many different types of business structures available for entrepreneurs to choose from in the UK and is being a sole trader the right business structure for your business?
In this article, we’ll explain:
- What a sole trader is;
- Self employed sole trader versus limited company – the difference between and the advantages and disadvantages of each legal structure;
- What you should do before you register as a sole trader;
- How to register as a sole trader; and
- Which taxes sole traders and self employed people need to pay.
Sole traders – at a glance
What is the definition of a sole trader? A sole trader is the outright owner of a business which is not registered as a separate legal entity with Companies House.
All profits made by a sole trader belong to them and tax must be paid on those profits in the form of Income Tax, National Insurance, Capital Gains Tax, and more. We’ll cover these taxes later on.
Sole trader vs limited company – the advantages and disadvantages
When you ask an accountant the “sole trader vs limited company?” question, the answer they give will depend on a lot of factors.
Who pays more tax?
Directors and shareholders of limited companies are also responsible for paying Income Tax and National Insurance but the way they pay themselves is generally a lot different. They also remunerate themselves in dividends – dividends are distributions of post-tax profit made by a limited company. The tax paid on dividends is a lot lower than the Income Tax and National Insurance paid by a sole trader.
“Unlimited liability”
A limited company is a separate legal entity which can enter contracts, take out loans, employ people, and so on. If a limited company goes under, a director is not personally liable for any debt the company has incurred as a business owner.
However, a self-employed person like a sole trader also have unlimited liability for the debts they incur as a business owner. This means that, should your sole trader business go under, the companies your business owes money to will chase you for the debt and some may seek to seize your personal assets. When they take ownership of your personal assets and resources, they will then choose to sell them to recoup the losses they have made on your loan.
In theory however, this difference between running a sole trader business and a limited company is not as set as it appears. When a bank or a finance company lends a small or new-start limited company money, they will require the directors to take out personal guarantees which mean that, should the new business fail, the lenders will pursue the directors for their personal assets and resources too. This is, in essence, another form of unlimited liability which is not protected by a limited company’s legal status.
Easier paperwork?
With a sole trader business structure, you have one set of books you need to keep and, from those books, you can work out how much you need to pay in tax.
With limited companies, you need to keep separate personal and business records. There’s a lot less paperwork involved in being self employed and running a sole trader business and, if you’re a contractor, you don’t have to worry about IR35 either.
You also have to make payment to a solicitor or company formation agent to incorporate your limited company.
Can everyone see my annual accounts?
Limited companies are required by law to submit their accounts every tax year to Companies House. Anyone with access to the internet can search Companies’ House website to access your accounts. Credit reference agencies also use this when determining your company’s credit score (different to your own individual credit score).
There is no requirement to publish accounts as a sole trader business so no-one other than you, your accountant, and HMRC will know how well your business performed in the previous tax year and earlier tax years. However, your ability to access finance to grow your business as a sole trader will be dependent on your own individual credit score.
Privacy
With a limited company, you have to complete confirmation statements each year (at a cost of £13 if you do yourself) confirming your business’ registered office, directors, and shareholders. People can see who you’re in business with and who has significant control over the decisions your limited company makes.
Each director and shareholder must provide a correspondence address as part of the confirmation statement. Many directors and shareholders still use their home addresses as the given correspondence address although more are now giving the addresses of their accountants and solicitors.
Before registering as a sole trader
Of all types of business, sole traders can launch in the quickest time with these three steps:
- Step 1 – create a business plan: you’re leaving behind the world of employment to become a sole trader. How much cash do you need to start your sole trader business? What level of profit do you need to make a comfortable and secure living? Where will you source your goods from and how will you take them to market? It’s best to get input and advice from an accountant before you launch so that you know whether self employment is a viable option for you;
- Step 2 – choose a business name: you could choose to trade with your own name – many self employed people do – or do you want something more distinctive, catchy, and original?; and
- Step 3 – take out business insurance: if you employ other people, operate from business premises, and/or work away from your office, you’ll need business insurance. You may also wish to take out keyperson insurance if you’re unable to work for an extended time through sickness or because of an accident.
You should also choose which accounting software package you want to use too. There are many advantages for sole traders by using accounting software – the biggest two are that you know how well your business is performing in a real-time basis and your accountant can use the information you enter into it to reduce the amount you’ll be charged in taxes.
Registering as a sole trader
When you’re ready to register as a sole trader, this is how you do it. You register using this online form at HM Revenue and Customs’ (HMRC) website for Self Assessment.
You pay tax dependent on the financial information contained on your Self Assessment form. The tax you pay to HMRC is dependent on the level of profit you make during the year – we’ll share with you what taxes you have to pay when you run a sole trader company below.
Remember that you have to register for HMRC’s Construction Industry scheme if your business is involved in alterations, building repairs, building work, cleaning the inside of a building after construction work, decorations, demolition, dismantling, heating, lighting, power, water, and ventilation system installation, laying foundations, providing access works, or site preparation. Here’s the link for that.
Within 10 days, you’ll get an activation code from HMRC allowing you access to your “Government Gateway” account as well as your Unique Taxpayer Reference number – you or your tax agent need to quote your Unique Taxpayer Reference number if you’re contacting HMRC .
Which taxes are sole traders responsible for paying?
Sole traders are responsible for paying some or all of the following taxes depending on their level of profitability and whether they employ staff or not.
Tax
You pay 20%-45% of your profits to HMRC in tax depending on how much money you make in a given tax year. Your first £12,500 of earnings each year is tax free.
Class 2 National Insurance (NI)
Class 2 NI costs £3.05 a week but you’re only responsible for paying it if your business makes £6,475 profit or more.
Class 4 NI
The main difference with Class 4 NI is that it is based upon a percentage of your business profits. Sole traders making £9,501 in profit or more during the tax year are charged 9% of that profit in Class 4 NI. The charge is 2% of any profit sole traders make above £50,000.
Employment taxes
You will have quite a number of extra responsibilities as a sole trader if your business employs other people. There’ll be extra taxes you need to pay and the combination of having to run a payroll and workplace pension scheme will mean lots of additional paperwork.
You will almost certainly need business accounting software to run payroll or use an accountant or a bookkeeper for this.
Capital Gains Tax
You are required by HMRC to pay Capital Gains Tax (CGT) on profits made following the disposal or sales of most assets (excluding your primary residential property) within a tax year. At time of writing, the CGT annual allowance is £12,300 in profits under which no CGT is payable.
Do I need to register for VAT?
You must register for VAT if your turnover is greater than £85,000 during the course of a tax year or whose turnover could exceed £85,000 within the next 12 months.
There are additional responsibilities for sole traders whose businesses are registered for VAT.
What is a Self Assessment tax return?
A Self Assessment tax return is the online/paper form a self employed person is required to fill out every year which informs HMRC of the income/profit you made during a tax year.
You must complete and submit your Self Assessment by 31st January every year – it contains financial information from the previous 6 April to 5 April period. For example, sole traders’ next Self Assessment must be completed and submitted by 31 January 2022 and this covers the financial period of 6 April 2020 to 5 April 2021.
On or by 31 January each year, in addition to completing the form, you must make payment in full for the tax you owe plus an advanced payment towards your next Self Assessment bill. On the 31 July each year, you make a second advanced payment towards your next Self Assessment bill. To ensure compliance with HMRC regulations, it’s crucial for self-employed individuals to complete and submit their Self Assessment tax returns on time. Seeking guidance from a knowledgeable self-assessment accountant can streamline this process, providing valuable insights into managing your financial obligations effectively.
Can HMRC check my financial records?
You are personally required by law to keep records of your trading activities. You must keep your records for at least 5 years after the 31 January submission deadline of the relevant tax year. HMRC could check your payroll records for up to 3 years and they could check VAT records for up to 10 years. However, if HMRC can prove deliberate fraud, this can increase to 20 years.
Black And White Accounting
Do you have a business idea, or are you already setup and looking for some support? If so, please get in touch with us today by contacting Black and White Chartered Certified Accountants, filling in the “Got a Question” form on the right, or calling us on 0800 140 464.
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